Student Loans – The Next Mortgage Meltdown

September 4, 2009

An entire generation of our country’s young people face a financial Armageddon of sorts. The promise of a better future through education has turned into a means by which student lenders trap kids in oppressive debt, often with outrageous interest rates. These young people, just beginning life on their own, are unable to get out of the debt cycle, often for the rest of their lives. It sounds ominous, but it’s happening.

Student Loan Lenders Face Scrutiny–and Lawsuits

Take easy credit terms, anxious and unsophisticated borrowers, and a commodity pitched as the ticket to wealth and security. Result: financial meltdown.

If that sounds like the housing market, it’s because the student loan industry has similar characteristics. Like mortgages during the housing boom, student loans are easily available and eagerly embraced by borrowers, lenders, and society. Like homeownership, a college education is promoted as the key to middle-class prosperity, a solid investment worth borrowing to the hilt for. Like mortgages, some private education loans were securitized and sold in bundled packages that mixed high-risk and low-risk borrowers.

And like homeowners facing foreclosure, students face loan burdens so onerous that default seems inevitable.

“As a nation, we have $700 billion in student loan debt,” said Alan Collinge, author of the new book The Student Loan Scam: The Most Oppressive Debt in U.S. History and How We Can Fight Back and founder of the Seattle-based group Student Loan Justice. “Student loans have a higher default rate than any other loan, including credit cards, car loans, home loans, and almost anything else.”

Many borrowers allege that the len­ders they trusted used predatory lending and collection practices. Because student loans are exempt from many rules governing consumer loans, the potential for abuse is high, critics say. The growing number of complaints has led to scrutiny by government investigators and private lawsuits against the lenders.

In 2007, a nationwide investigation headed by New York Attorney General Andrew Cuomo found that three major student lenders-SLM Corp., better known as Sallie Mae; Citibank; and Education Finance Partners-had given universities kickbacks in exchange for being designated their “preferred lenders.” The investigation led to a settlement of $6.5 million.

In June, Deanne Loonin, director of the Student Loan Assistance Program of the National Consumer Law Center, testified before the Department of Education about lending and collection practices in the student loan industry, especially at for-profit schools.

“The current messy patchwork of federal law is inadequate to protect students and taxpayers,” Loonin testified, and “using private collection agencies not only to collect but also to resolve disputes with borrowers has been a disaster for borrowers.”

“With the government guaranteeing many loans and without consumer protections, you get predatory lending on the front end and abusive collection tactics on the back end,” said Nicole Mayer, a lawyer with the Tampa-based James Hoyer law firm. “It’s a double whammy of the worst kind.”

There are three types of student loans: federally guaranteed loans backed by the Federal Family Education Loan Program (FFELP), including Stafford and PLUS loans, administered by private lenders like Sallie Mae; federally guaranteed loans by the Department of Education issued directly to students; and private education loans (PELs) that are not federally guaranteed, often those issued by for-profit schools, such as trade and technical schools.

Most students use a mix of loan types. The average student’s debt is nearly $20,000 by graduation-double the amount owed a decade ago. Recent media reports have highlighted the problem of borrowers defaulting on these loans: In July, for example, the newsmagazine program Now on PBS profiled a social worker in Baltimore who was evicted when, after losing her job, she was unable to afford both her rent and her student loan payments despite repeated attempts to renegotiate her terms.

“The Department of Education will tell you that it’s not a big problem, that the system works well and defaults are low,” said Collinge. “It’s a lie.” Collinge pointed to a 2003 audit by the department’s Office of the Inspector General, which found that the lifetime default rate for students at four-year colleges was between 19 percent and 31 percent, depending on the type of loan. For students at two-year colleges, the rate was as high as 42 percent, and students at for-profit schools had a high-end default rate of 51 percent.

Unique legal status

Student loans enjoy a unique legal status unlike most other consumer loans. “You can’t discharge them in bankruptcy. They don’t have to comply with federal truth-in-lending laws, state usury laws, statutes of limitations on debt collection, or much of anything else,” said Collinge. “If it’s a federally guaranteed loan, the lenders can garnish your paychecks, your Social Security and disability checks, and your tax refunds.”

Michael Zahara, a former default prevention specialist at the Las Vegas office of the Student Assistance Corp. (SAC), a debt collection agency owned by Sallie Mae, said, “What we want is to get back what was lost: The protection of the district courts. Let a judge rewrite the terms of a loan, or even discharge it. Give people back the access to the courts.”

Students can only discharge their loans, including PELs, in bankruptcy by proving that paying them poses an “undue hardship.” As a result, hard-pressed graduates have little recourse but to ask for a forbearance.

Granted by the lender when a borrower finds it impossible to meet monthly payments, forbearance halts the collection process. But during forbearance, interest and penalties continue to accumulate, resulting in loan amounts that can double or triple once the borrower begins paying again.

Robert Applebaum, a lawyer in New York who founded the Facebook group Cancel Student Loan Debt to Stimulate the Economy, which claims almost 200,000 members, wrote on the New York Times “Room for Debate” blog in June that he used a forbearance after law school to work in public service law. Then he “watched as the amount I owed ballooned by nearly $20,000 during the time I served the community.”

On his Facebook site, Applebaum writes that the student loan industry has created a generation of “educated poor, with student loan debt making ever more college graduates and young professionals unable to buy a house or start a family or a small business.”

Mayer of the James Hoyer law firm filed suit last year against Sallie Mae, the country’s largest distributor of student loans. The suit alleges violation of the federal Truth in Lending Act (TILA) and the Equal Credit Opportunity Act (ECOA). In March, a district court in Connecticut granted Sallie Mae’s motion to dismiss the TILA charge but did not dismiss the ECOA charge. (Rodriguez v. SLM Corp., 2009 WL 598252 (D. Conn. Mar. 6, 2009).)

Suing Sallie

Many critics of the student loan industry say lenders like Sallie Mae are pressing borrowers to go into forbearance, sometimes even against the students’ will.

Zahara said SAC loan administrators routinely pushed borrowers into forbearance to hide the number of bad loans on their books. “I would estimate that in my facility alone we had about $350 million in bad loans,” he said.

In 2005, Zahara filed a qui tam lawsuit against his former employer, alleging violations of the federal False Claims Act and charging that Sallie Mae and SAC “allowed their employees and agents to falsify loan records pertaining to delinquent FFELP loans held by Sallie Mae.” His suit claims that “fabricating forbearances benefited defendants and defrauded the federal treasury.” In March, the lawsuit was dismissed without prejudice so that Zahara could find a new lawyer. (Zahara v. SLM Corp., No. 1:06-cv-088-SEB-JMS (S.D. Ind. Mar. 12, 2009).)

Last year, Sallie Mae shareholders also sued the company, saying it engaged in risky behaviors by granting loans to high-risk borrowers (primarily students attending for-profit schools). The plaintiffs claim that Sallie Mae “used for­bearance as a means to reduce delinquencies and avoid charge-offs on the increasing number of loans that were past due with no documented basis for future repayment and to avoid charging off those loans.” (In re SLM Corp. Secs. Litig., No. 08-CV-1029 (WHP) (D.N.Y. filed Dec. 8, 2008).)

According to the complaint, “If these were private credit loans where the lender bears the risk of loss, Sallie Mae would have forced the loan into default long ago and cut its losses; but because FFELP loans are essentially risk-free to Sallie Mae, it keeps extending the loans knowing that the government is ultimately responsible for paying the loan balance when the borrower defaults.”

The lawsuit also claims that “based on information provided by former employees of SLM that worked in collection centers . . . [the] policy was consistent in encouraging PEL collection employees to move past-due loans into forbearance whenever it appeared that payment was not forthcoming. SLM did anything it could to avoid charging-off a loan.”

Signs of relief

There are signs that the government is trying to head off the problem before the numbers get too dire. Student advocates praised the Obama administration’s decision to remove “middleman” lenders like Sallie Mae and make all student loans direct government loans.

In July, the Department of Education instituted the Income-Based Repayment (IBR) plan, which caps student loan repayments to levels based on income, state of residence, and family size. Also, any debt and interest remaining after 25 years will be forgiven. Students who opt to work in specific nonprofit or public-service jobs could be forgiven after 10 years of IBR payments.

Mayer said she was taking a “wait and see” approach to the IBR, pointing out that it did not affect PELs, which cause most of the hardship. Collinge said the government was taking some good first steps but that these tended to sweep aside the real issue, which is to return bankruptcy and other consumer protections to people who have student loans.

“We’re not fighting to let people skate on their debts,” he said. “We just want people to have the same protection that applies to every other kind of debt.”

Whistleblower Connection

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If you have specific evidence a company is defrauding the government, contact the James Hoyer Law Firm. As a whistleblower, you can file a legal action in the government’s name to recover money for taxpayers.